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Suppose that the economy is already at the natural level of real GDP and that aggregate demand is pr

Suppose that the economy is already at the natural level of real GDP and that aggregate demand is pr

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Suppose that the economy is already at the natural level of real GDP and that aggregate demand is  projected to increase further, which will cause the  AD  curve in Figure 2  to shift from  AD 1  to  AD 2 Figure 2 Combating inflation using contractionary fiscal policy As real GDP rises above its natural level, prices also rise, prompting an increase in wages and other  resource prices and causing the  SAS  curve to shift from  SAS 1  to  SAS 2 . The end result is inflation of  the price level from  P 1  to  P 3 , with no change in real GDP. The government can head off this inflation  by engaging in a  contractionary  fiscal policy designed to reduce aggregate demand by enough to  prevent the  AD  curve from shifting out to  AD 2 . Again, the government needs only to decrease 
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